Portfolio Foundations

Most investors begin by asking: "Is this a good investment?" That is the wrong question. The better question is: "How does this investment behave alongside everything else I own?" A portfolio is not a collection of individually excellent assets — it is a system of relationships between assets. The…

Return is the gain or loss on an investment over a period, usually expressed as a percentage. If you invest £1,000 and it becomes £1,080 after a year, your return is 8%. Returns can come from two sources: income (dividends, interest, rent) and capital appreciation (the asset increasing in value)…

There are two common ways to calculate the average return of an investment over multiple periods. They produce different numbers, and the difference matters enormously for long-term investors.

When a savings account advertises 5% interest or a fund reports 10% annual returns, those figures are nominal returns — they reflect the raw percentage change in the monetary value of the investment. But money is not valuable in itself. What matters is purchasing power: how much the money can buy.

Suppose Fund A returned 18% last year and Fund B returned 12%. Which was the better investment? The answer is: it depends entirely on how much risk each fund took to achieve those returns.

In everyday language, a "volatile" investment is one whose price jumps around unpredictably. In finance, volatility has a precise definition: it is the standard deviation of an investment's returns over a given period, usually expressed on an annualised basis as a percentage.

Maximum drawdown (MDD) is the largest peak-to-trough percentage decline in the value of a portfolio or fund over a specified period. It captures the worst loss an investor would have experienced if they had bought at the highest point and sold at the lowest point before a recovery.

Two investors can receive identical annual returns — the exact same percentages, in different orders — and end up with dramatically different wealth outcomes. This is not a paradox. It is a consequence of the interaction between the sequence of returns and the timing of withdrawals.

Correlation is a statistical measure of the degree to which two variables move together. In a portfolio context, it describes how the returns of two assets relate to each other over time. Correlation is expressed as a coefficient ranging from +1 to -1.

Harry Markowitz's 1952 paper "Portfolio Selection" contained one of the most important mathematical insights in the history of finance: combining assets with low or negative correlation reduces overall portfolio risk without necessarily reducing expected return. This is the basis for calling…

Portfolio construction using correlation relies on an assumption that is rarely stated explicitly: that the correlations measured from historical data will persist into the future — or at least will be roughly stable during the periods when the portfolio is tested. This assumption is reasonable in…